But according to a new Spectrum study, the business model is still new to most investors. When asked to rate their familiarity with various investment terms on a scale of 0 to 100, where 0 is not at all familiar and 100 is very familiar, wealthy investors rated their knowledge of the term “robo-advisor” at just 15.47. The younger the investors were, however, the more familiar they were with robo-advisors.
On the plus side, robo-advisors democratize financial advice. With a robo-advisor, there are no investment minimums; anyone can use the programs. While that sounds convenient and beneficial, there are dangers in providing “expert” advice for everyone. Yes, the robo-advised, largely passive index-based portfolios may benefit investors by decreasing investment costs and diversifying their holdings. However, there is a more significant problem that robo-advisors can’t solve. Robo-advisors can’t counsel clients to ensure that they don’t bail out of the market at precisely the wrong time during a bout of market volatility. And they can’t counsel clients to ensure they don’t succumb to irrational exuberance during market highs.
As we know, thanks to the market research firm Dalbar’s 20 years of Quantitative Analysis of Investor Behavior (QAIB) studies, individual investors tend to sell low and buy high, which results in lower returns when compared to institutional investors. Dalbar’s 2014 QAIB report showed a 20-year return of 9.22% for the S&P 500 compared to the average investor’s return of 5.02%.
Studies like Dalbar’s QAIB also help underscore the value of a trusted advisor’s relationship-oriented services such as wealth management and behavioral coaching. Estate and succession planning or advice on long-term care insurance or charitable giving just can’t be delivered by a robo-advisor. A trusted advisor (i.e., a real human being) can help you to set clear goals and monitor your progress throughout inevitable life changes and market swings. Especially in today’s fast-moving, volatile market, this work is both an art and a science.